Thursday, October 28, 2010

Amid all the excitement about Mainz’s exhilarating start to the new German season, Borussia Dortmund’s surge into second place in the Bundesliga, winning seven of their first nine matches, including the impressive disposal of fierce local rivals Schalke 04 in the Revierderby, has gone largely unnoticed, even though Jürgen Klopp’s young, athletic team puts on show a similar brand of aggressive, attacking football.

These impressive displays provide the most tangible evidence yet that Borussia have largely recovered from their financial difficulties of 2005 when they flirted with bankruptcy. Since then, the club has been languishing in the football doldrums, but has made considerable progress in the last three seasons. From the mid-table obscurity of 13th position in 2008, they improved to 6th place in 2009 and managed to qualify for the UEFA Europa League last season by finishing in a very creditable 5th.

Although the club’s 2009 annual report boasted, “BVB is back”, it is still too early to say whether Borussia Dortmund have enough strength in depth to maintain their challenge for the Bundesliga. What we can declare with more confidence is that this team still has a long way to go to emulate the glory days of their legendary counterparts from the golden era of the mid-90s.

In fact, Borussia Dortmund is a club steeped in history, celebrating its centenary last year with a friendly match against Real Madrid. It is one of the most successful, well known and popular German football clubs, having won the Bundesliga six times, the German (DFB) Cup twice and the European Cup Winners’ Cup in 1966 – when they were the first German team to secure a European title, beating Liverpool 2-1 in the final.

However, more recently, Borussia’s sights have been set somewhat lower with the club happy to merely qualify for the UEFA Cup in 2008 by the back door, after losing the DFB Final to a Bayern Munich side that had already secured a Champions League spot by winning the German championship. In fairness, this did mark a step forward, given that it was the first time the club had qualified for Europe since 2004. Furthermore, the previous season had seen the club involved in a relegation battle, that provoked two changes in management, when Bert van Marwijk was replaced in the winter break by Jürgen Röber, before a run of six defeats in seven matches resulted in yet another new coach in the shape of former German national, Thomas Doll.

"Nuri Sahin - Turkish delight"

Terrible times, but since Jürgen Klopp arrived in May 2008, the team has gone from strength to strength, keeping the incoming coach’s promise of showing supporters “full-throttle football with passion.” The club’s philosophy entails building up a very fit team of young, ambitious and talented players, backed up by experienced “pillars”, which allows them to apply an energetic, pressing game that is much appreciated by their huge crowd. The jewel in the crown is the 22-year old Turkish playmaker Nuri Sahin, who first played in the Bundesliga at just 16, but Borussia’s youngsters have also been recognised by the German national team with attacking midfielder Kevin Großkreutz and central defender Mats Hummels making their debuts this year.

To some extent, Borussia have had to make a virtue out of necessity following the constraints imposed by their economic meltdown a few years ago. The club’s difficulties first became apparent in 2002, when poor financial management resulted in an unmanageable debt load that meant the club had to sell its famous Westfalenstadion to a real estate trust. All the funds raised from their flotation on the German stock exchange two years before (the first and to date only listing of a German football club) had effectively been squandered.

Worse was to come in 2005 after the club spent heavily on expensive signings and high wages in the pursuit of further European glory. In a scenario horribly reminiscent of Leeds United’s misguided strategy, Borussia effectively gambled on competing regularly in the Champions League to fund their spending. Although they managed to avoid relegation, the club’s record losses and massive debts put them in a “life-threatening situation.”

The approach of trying to buy success was far too ambitious for a club of Borussia’s relatively limited means and its spectacular failure meant that the old regime, which had been in charge for nearly 20 years, had to be replaced. The new chairman, Hans-Joachim Watzke, summed up the reasons for their downfall, “We have problems, because our success was not as we hoped. Perhaps we spent money that we don’t have. We thought that we could be in the Champions League for many years.” The line between success and failure in the world of football is indeed a thin one.

"Neven Subotic - in demand"

However, football clubs can always count on the “never say die” spirit of their supporters and in their moment of need the BVB fans did not let their club down. Their “We are Borussia” campaign resulted in Dortmund’s community of citizens, companies and public authorities combining to help save the club, so much so that in 2008, the club’s annual report could proudly announce, “Three and a half years after facing the very real threat of insolvency, Borussia Dortmund has regained a solid economic foothold and is so sound that we no longer need to worry about financial problems, not to mention problems that would threaten our continued existence.”

Having said that, it is doubtful whether the club could have carried on in 2005 without some very understanding creditors and bank managers, who deferred stadium rent and interest payments until 2007. The club also had to take out yet another loan to help pay the players’ salaries, while they were forced to shore up the balance sheet in 2006 with significant capital increases that reduced liabilities and improved the equity position from €15 million to €61 million. The funds raised enabled the club to achieve a more manageable debt maturity structure and obtain improved interest rate terms.

At least they avoided the potential ignominy of accepting help from their rivals Bayern Munich in order to bolster its ailing finances, which looked like a distinct possibility at one stage. The club also rejected a sponsorship offer from Beate Uhse, a chain of sex shops. It’s not clear which would have been the bitterer pill to swallow for BVB fans.

"The most beautiful stadium in the world?"

Instead, in 2006 the club took out a 15-year loan of €79 million with Morgan Stanley, thereby laying the foundations for the long-term stabilisation of the company. They used €57 million to buy back the remaining 51% of the shares in their stadium from the Molsiris real estate investment fund, thus reducing the high rental expenses and giving them more room to manoeuvre. The remaining €22 million was used to reduce and refinance existing liabilities, which enabled the creditors’ agreement of March 2005 to be annulled in June 2006.

The restructuring process was completed two years later, when €50 million of cash received after signing a new 12-year marketing agreement with Sportfive was used to fully repay the Morgan Stanley loan many years ahead of schedule. The club promised that this move would not only further reduce its liabilities, but would free up funds to improve its sporting competitiveness over the next few years. The advancement in league position in the last couple of seasons would indicate that the club has been true to its word.

That improvement has also been reflected in the club’s financials. Following the club’s annus horribilis in 2005 with an enormous €55 million loss, the club instigated some drastic cost cutting, slashing the wage bill by €10 million and reducing player amortisation by €13 million over the next two years. Allied with an increase in the Bundesliga TV deal, the sale of David Odonkor to Betis and money distributed after the 2006 World Cup (held in Germany), this produced a remarkable €15 million profit in 2007.

In each of the last two years, Borussia Dortmund have reported a loss of about €6 million, though they have just about broken even at the operating level (before interest payments). That’s not too bad in the current economic climate with the club “unable to completely sidestep the fallout from this crisis”, especially in the absence of major European competition to boost revenues.

This year’s results were also impacted by lower profits from player sales and would actually have shown an improvement on the prior year if Nelson Valdez’s €4 million summer transfer to newly promoted La Liga side Hercules had taken place a few week earlier. Like all other clubs, Borussia’s results were affected by the World Cup in South Africa, which pushed back most transfer activity to beyond the closing of their accounts at end-June. Having said that, over the years, player trading has not contributed a great deal to Borussia’s profits (never higher than €5 million), even when their finances forced them to offload a number of players.

Even though Borussia Dortmund achieved their highest position in the Deloittes Money League in 2009 since 2003, the reality is that their revenue is a long way short of most major European clubs. Their 18th place with revenue of €103 million is the lowest of the five German teams in the Money League, behind Bayern Munich €290 million, Hamburger SV €147 million, Schalke 04 €124 million and Werder Bremen €115 million. In fact, Bayern’s revenue is almost three times that of Borussia, while Real Madrid and Barcelona generate almost four times as much as them.

What is immediately apparent is the very low income from match day and television (with no Champions League boost), though the commercial revenue is surprisingly high – more than teams like Arsenal, Lyon, Juventus and Inter. In fact, commercial revenue contributes the highest percentage of total revenue of any of the teams in the Money League at 57% with only fellow German clubs Bayern (55%) and Schalke (49%) coming anywhere near that astonishing figure.

Revenue has risen 42% since the dark days of 2005, largely through the advances on the commercial side, which is a big reason for the improvement in the bottom line. However, since breaking through the €100 million barrier for the first time in 2008, there has hardly been any increase, which might suggest that there is a limit to the scope for future revenue growth – unless they qualify for the promised land of the Champions League or take the unpopular step of raising ticket prices.

Total income has actually fallen by £9 million since 2008, mainly due to the €7 million decline in other operating income, which was inflated that year by a couple of once-off factors, namely compensation paid to clubs that released international players for the 2008 European Championships and the sale of the swap transaction with Deutsche Bank as part of the repayment of the credit facility with Morgan Stanley.

At this stage, I should make clear that I am using the Deloittes definition of revenue in order to facilitate comparisons with other European clubs, so have excluded transfer income (€11.2 million in 2008/09). Adding that to the Money League revenue of €103.5 million gives the €114.7 million revenue reported by Borussia Dortmund. You should also note that the costs (accumulated depreciation) associated with transfers have been deducted from other expenses to give the profit on player sales, e.g. in 2008/09 transfer income of €11.2 million less transfer expenses of €7.2 million produced a profit on player sales of €4.0 million.

Some will be a little perplexed about the paradox of Borussia Dortmund enjoying some of the largest crowds in Europe, yet having one of the lowest match day revenues in the Money League with only Roma and Juventus generating less than Borussia’s €22 million in 2009, but the reason is an obvious one: very low ticket prices. This is the antithesis of the English approach, which sees Manchester United and Arsenal earn five to six times as much from this revenue stream, but Bayern’s €61 million is also nearly three times as much as their German colleagues.

Last season, Borussia Dortmund’s incredible average attendance of 76,400 was the second highest in Europe, only beaten by Barcelona 78,100, but above Manchester United 74,800. This was easily the largest average in Germany with the next highest teams being Bayern 69,500 and Schalke 61,200. The Borussia fans’ interest shows no sign of slowing down, as the club has just established a new record for season tickets for 2010/11 at a mighty 51,200, beating last season’s previous high of 50,700.

Borussia’s high attendances (and low match day revenue) can be partially attributed to the large number of standing places (around 27,000) for which tickets are priced as low as €12. Around 25,000 of these can be found on the famous Südtribüne terrace, known as the “Yellow Wall”, which is the largest standing area in European football and provides each home game with an intensely passionate atmosphere.

It is surely no coincidence that the Bundesliga has the lowest ticket prices of Europe’s five major leagues and consequently the highest attendances. The Bundesliga chief executive, Christian Seifert, argues that keeping tickets cheap is part of German clubs’ core value of placing the supporter first, as they know how valuable the fan base is. According to Deloittes, the average price for a Bundesliga match is €19 compared to €51 in the Premier League, which is almost three times as much. That’s a huge difference, especially for younger supporters.

"Sebastian Kehl - the leader of the pack"

This is an important part of football culture for German fans, who would be extremely resistant to higher ticket prices. Recently, Borussia fans voted with their feet when they boycotted the derby at Schalke, after their rivals demanded a 50% surcharge for this match. The chairman of one of the BVB supporters groups, Marc Quambusch, argued that this was the thin end of the wedge, “If we simply accept higher prices, we’ll end up like the Premier League, where young people are priced out and the crowd is getting older and older.” Jürgen Klopp injected some humour into the situation, when he said, “I think it’s great our people don’t go there to finance (new striker) Klaas-Jan Huntelaar.”

For the moment, there are no such problems in Borussia’s imposing stadium, now officially named Signal Iduna Park, which is the largest football ground in Germany with a capacity of 80,700. This is obviously an extremely valuable asset that can also be used to host international matches, when the capacity is reduced to 67,000 by converting the standing areas to seats (which only takes two days). The Times described it as the “most beautiful stadium in the world”, writing, “Every Champions League final should be held in Dortmund. The place was built for football and its fans.”

When you look at Borussia’s paltry TV revenue of €22 million in 2009, which is by far the lowest in the Money League, it gives you some idea of the financial challenges they still face. Clearly, this would be much higher if they reached the Champions League (Wolfsburg, for example, received €26 million last season), but in the meantime their broadcasting revenue is almost entirely sourced from the DFL (German Football League).

The current deal runs for four years from 2009 to 2013 and is worth €1.65 billion for domestic rights, which works out as €412 million per season. This is slightly higher than the previous three-year contract, which was worth just over €400 million a year, though that did represent a 40% increase on the preceding agreement. The Bundesliga deal is about 40% lower than the €700 million received per season by the Premier League for domestic rights, which is bad enough, but is nothing compared to the disparity on overseas rights, where the Bundesliga only receives €40 million against €550 million for the Premier League. For all its many attractions, it is clear that the Bundesliga has not successfully marketed itself globally. As a result, German clubs receive far less TV money than their English peers, e.g. Bayern earned €70 million in 2008/09, which was considerably less than Manchester United’s €117 million.

The DFL TV money is distributed among clubs using a weighted calculation based on the performance over the last four seasons plus a bonus depending on the final position in the current season. However, Borussia’s television revenue has actually decreased over each of the last two seasons from €26 million to €21 million, even though their positions in the Bundesliga has been improving. The €4 million fall in 2009 was due to the team’s elimination in the third round of the DFB Cup, compared to reaching the final the previous season, while the 2010 decline was again due to fewer cup matches.

"Happy days are here again"

As we highlighted earlier, what really drives Borussia Dortmund’s revenue, like so many German clubs, is their commercial operation, which this year topped €60 million for the first time, comprising €39 million sponsorship, €8 million merchandising, €9 million catering and €5 million rentals. It was just as well for this revenue stream that the club bought back its merchandising trademark in 2006, which had been sold in 2000 as part of its efforts to raise money.

The club has implemented a strategy of building trusted long-term relationships with commercial partners, many of whom have recently extended their contracts with the club, including Sportfive, who have signed with the club until 2020, by which time they will have been the club’s marketing partner for 20 years. Similarly, insurance and financial services provider Signal Iduna has extended its stadium naming rights deal, whereby it pays €4 million a year, until 2016.

This approach has also been followed by shirt sponsor Evonik, which prolonged its agreement to 2013, paying over €7 million a year. They had been part of an imaginative campaign whereby Borussia played the 2006/07 season with a green and yellow exclamation mark on their shirts, while the RAG energy company came up with the Evonik brand. German clubs have proved very adept at securing valuable shirt sponsorship deals, so much so that a report by sports consultancy StageUp showed that shirt sponsorship revenue in the Bundesliga is actually higher than the Premier League.

"Lucas Barrios - sharp shooter"

Nike were replaced by Kappa as kit suppliers in 2009/10 in a three-year deal worth €4 million a season, while Sportfive have succeeded in increasing the number of so-called “champion partners”, the list now including Sprehe Feinkost, AWD, Coca Cola, Radeberger and Sparda Bank.

Moving on to expenses, Borussia have clearly made efforts to control their costs. Not only have their operating expenses been virtually unchanged over the last three years at around €110 million, but they are still lower than the €117 million spent in 2005. Having said that, other expenses of €45 million seem fairly high, though this does include €17 million for match operations, €11 million advertising, €6 million administration and €5 million materials (primarily merchandising).

Where Borussia have been particularly effective is in controlling their wage bill, as evidenced by the wages to turnover ratio, which has never been above 48% since the big spending year of 2005. The club has prioritised a reduction in its payroll, so wages were cut €2 million last season to €48 million, giving a very respectable wages to turnover ratio of 46%.

This is not overly surprising, given the Bundesliga’s focus on this ratio, as can be seen by Deloitte’s last review of the major European leagues, which revealed that the average wages to turnover ratio for the Bundesliga was just under 50%, compared to 66% in the Premier League. This is the main reason why the Bundesliga is more profitable (€172 million) than the Premier League (€93 million), even though its revenue (€1.6 billion) is much lower than its English equivalent (€2.4 billion).

Even so, Borussia’s wages of €46 million are less than a third of Bayern’s €139 million, though the champions’ revenue is, of course, also around three times higher. To provide an English comparison, Borussia’s wage bill is about the same as Bolton Wanderers, which should place their European aspirations into context. It must be tough to compete against the likes of Real Madrid and Inter Milan when their wage bill is four times as much as yours.

The trend in player amortisation, namely the annual cost of writing down the cost of buying new players, also reflects Borussia’s fall and rise. It peaked at €18 million in 2005, but was then greatly reduced to €5 million in 2007, as the club reacted to its financial predicament, but it has steadily risen again, albeit to a much lower level at €9 million, as the club has ventured back into the transfer market, now that the worst of its monetary problems seem to be behind it. Again, this is much lower than other clubs with Bayern’s €33 million being a pertinent comparison.

The graph of net transfer spend for the last 12 years beautifully demonstrates this trend and highlights one of the main reason for Borussia getting into debt. In the five years before the fateful 2004/05 season, the club’s net spend was €95 million (gross €128 million), but then they hit the brakes with net surpluses generated over the next three years, followed by very modest net spend in the last four years. Over that seven-year period, Borussia had a net surplus of €5 million – a stark contrast to their extravagant epoch.

The club obviously now has an objective of balancing its books, which effectively means that it has to sell before it can buy. In recent years, this has meant the sale of players like Alex Frei, Mladen Petric, Steven Pienaar and Tomas Rosicky. Even now, after all that the club has done to reinforce its financial stability, it still cannot operate with complete freedom in the transfer market. In order to meet financial targets, the club may not pursue certain players if that would incur additional debt. For the same reason, a player may have to be sold, even if the coach wants to keep him on sporting grounds. That might be the case with the highly rated defender, Neven Subotic, next summer.

Borussia’s sporting director, Michael Zorc, has been criticised for his track record on player purchases, but he must sometimes feel like he is fighting with one hand tied behind his back. Nevertheless, he has still managed to unearth some gems, such as the brilliant Shinji Kagawa, who was signed for only €350,000 from the J-League, and has already won over the fans by scoring twice against bitter rivals Schalke, and top scorer Lucas Barrios, bought for €4 million from Paraguayan side Colo-Colo, whom Zorc described as “a goal machine, the best striker we have had since Stéphane Chapuisat.”

The club also possesses what it describes as “hidden reserves” among the playing staff, following its policy of recruiting young talent with a lot of potential. This means that their value in the transfer market is much higher than that recorded in the books. To further this objective, they have founded the BVB Academy to facilitate the targeted, comprehensive development of players aged between 19 and 23 years old.

Given that the club’s financial problems are still fresh in the memory, it is entirely understandable that Borussia exercise a degree of caution. Even though they have managed to reduce their net debt from €150 million in 2006 to €73 million today, mainly due to the repayment of the Morgan Stanley loan, this is still a high figure by Bundesliga standards. The loans have maturity dates between 2020 and 2026 with a weighted average interest rate of 6.6%, but, importantly, the club is not exposed to any interest rate risk thanks to the fixed interest nature of the credit agreements. However, despite making some loan repayments, the net debt has actually been creeping up over the past two years, as the club has increased its use of overdraft facilities up to €10 million.

Borussia Dortmund’s financial difficulties do beg the question of whether the Bundesliga’s licencing rules are not quite so effective in practice as we have been led to believe. These regulations include looking at a club’s books each March in order to assess the robustness of their budgetary plans before issuing them a licence to operate the next season. In addition, the “50+1” rule, which dictates that club members must own at least 50% plus one share in order to prevent the club being subject to the whims of an individual owner, theoretically means that clubs should not take on potentially damaging debt levels.

Despite these well-intended rules, a number of clubs have still managed to get themselves into deep financial trouble over the years, Borussia being the obvious example, but Schalke’s finances have also caused concern in the past few months. Clearly, no rules can ever be perfect and there will always be exceptional cases, but let’s hope that the Bundesliga has learned some lessons here and tightened up their procedures, including a better early warning system.

"Klopp hands - here comes Jürgen"

In order for Borussia to avoid returning to such a position, or, more positively, for the club to further improve, it will need to grow its revenue, but is this feasible?

Well, there are a few opportunities. The best route would be via success on the pitch, particularly qualification for the Champions League. If the club could achieve that (and keep qualifying year after year), it would be a whole new ball game financially. Fortunately for them, although this is not a walk in the park, it is far from insurmountable and they would have managed it last season if they had won either of their last two matches. The German league is also far more open than others, so it’s not a given that certain teams will always qualify no matter what. As Steve McClaren, Wolfsburg’s new coach enthused, “The beauty of the Bundesliga is any one of ten teams can win the title.”

They could also make more use of their magnificent stadium by staging international matches and marketing it for more events on non-game days. In fact, even though commercial revenue is already high, better use of the BVB brand could further improve merchandising sales, especially as Borussia Dortmund is the fourth most popular club amongst Germany’s football followers (according to market research). Finally, although the fans might not appreciate it, there is a lot of unrealised profit that could be crystallised by selling some of the up and coming young players to richer clubs.

"And it was all yellow"

The current strategy still needs to have an eye on gradually improving the financial structure, an approach that the club has described as “sustainability before speed.” In the period shortly after Borussia Dortmund came so close to extinction, the club revealed its new credo: “sporting success cannot be achieved without exercising good business sense.” Not the most stirring words that you’ll ever hear, but I’m sure that most BVB fans are thankful that the club appears to be in safe hands and they are heading in the right direction.

The rest of us should be equally happy that this grand old club survived and seems well on the road to recovery, if only so that we can continue to enjoy the spectacle of the “Yellow Wall” in full voice, which is one of the truly great sights in modern football. Forget Phil Spector, that’s what I call a wall of sound.

Tuesday, October 19, 2010

Despite their victory over Lille last weekend, Olympique Lyonnais’ start to the season has been far from convincing with manager Claude Puel reportedly being given three games to save his job. Coming off the back of two seasons where Lyon finished “only” second and third in Ligue 1, questions have been asked about whether Puel is the right man to take the team forward. Although this would have represented success for almost any other club in France, the end of domestic league dominance must have felt like failure to those supporters whose team won the League an unprecedented seven years in a row from 2002.

In fact, Lyon’s rise from relative obscurity to become the leading club in France by some distance is an amazing story. When Jean-Michel Aulas, a local software entrepreneur, bought the club in 1987, they were languishing in the second division, deeply in debt, and, in the new owner’s words, burdened with “no history and a public largely uninterested in football.” Two decades later, their finances have been revived and they are one of only four clubs to have qualified for the Champions League eleven years in a row (the others being Real Madrid, Manchester United and Arsenal), culminating in an appearance in the semi-finals last season for the first time ever.

"Jean-Michel Aulas - happy days"

This incredible transformation has not been as a result of a wealthy benefactor pumping money into the club (like Chelsea), nor is it down to a lengthy managerial dynasty (like Manchester United or Arsenal), but is the result of an exemplary strategic plan from the chairman and CEO, Monsieur Jean-Michel Aulas, which he kindly explained in the last management report, “In the first phase, from the club's purchase in 1987 until 1998, the priority was on advancing to Ligue 1 and consistent results in league play. In the second phase, beginning in 1999 when Pathé purchased a stake and lasting until 2010, the objective was to keep the club in Ligue 1's top three, and thereby take part in European championships. These objectives have been fully achieved.”

The long-term aspect of the plan has been a key element of Lyon’s improvement, as they have grown gradually. In a country famous among other things for the Tour de France, Aulas opted for a cycling analogy, “Each year we set as an objective to have progression. It’s like a cyclist: you can overtake the people just ahead of you,” though he later embraced four wheels, saying that he wants Lyon to become “the ultimate Formula 1 car, capable of shifting through the gears to cope with all types of road.”

While Aulas has received his fair share of criticism for running the club as if it were a business, his theme is that there is a virtuous circle in football: over time the more money a club makes, the more matches it will win, and the more matches it wins, the more money it will make.

Indeed, Lyon have been profitable for many years, though they suffered a large loss of €36 million in 2010 for the first time since 2004. The deficit would actually have been even higher without an €18 million tax credit, as the club reported a loss before tax of €54 million. This is somewhat of an aberration for Lyon, whose pre-tax profits had averaged an impressive €23 million in the previous four years.

Aulas has described the results as a “blip”, pointing to the generic problems facing football clubs in France, but the main reason for the changing fortunes at Lyon is obvious, as the profit made on player sales was tiny in 2010, compared to the customary €40 million or so achieved in the past few years. If this trend had continued, Lyon would once again have reported a profit in their latest accounts.

Player trading has played an important role in Lyon’s financial success with transfer fees making up a significant portion of the club’s revenue every year except the last, when the profit from player sales only reached a paltry €3 million, as no big transfer was made in the period. In the previous four years, the sale of players generated enormous proceeds of €220 million, resulting in considerable capital gains of €164 million.

"Benzema - good example of Lyon's strategy"

This is part of what the club describes as an “innovative business model”, whereby Aulas has excelled at acquiring players and selling them on for exuberant fees to more renowned clubs abroad. The list of his hugely profitable transfers is almost endless, including Mahamadou Diarra and Karim Benzema to Real Madrid, Michael Essien and Florent Malouda to Chelsea, Eric Abidal to Barcelona and Tiago Mendes to Juventus.

His skill in negotiating large transfer fees won him the grudging admiration of Sir Alex Ferguson, when the great Scot was asked about Benzema possibly moving to United, “Lyon’s president is a sharp man. He sold Essien for €38 million, Diarra for €26 million, Malouda for €19 million, Abidal for €16 million. And I congratulate him for that.”

The profits on such sales have been boosted by an increasing number of the players being sold coming up through Lyon’s training academy. In 2009 over 70% of the sales proceeds came from players trained at the academy, most notably Benzema whose transfer was alone worth €35 million. This has been assisted by the club investing €5 million in state-of-the-art training facilities, which were completed in 2008, with graduates such as Hatem Ben Arfa and Loïc Rémy being other prominent examples of the young talent graduating from the academy.

"You're having a Ben Arfa"

One of the main objectives given to Claude Puel was to smooth the transition of the young players trained at the academy into the first team and this strategy is starting to pay off with the emergence of the likes of Gonalons, Pied, Grenier and Lacazette. However, there has been a quid pro quo on the player trading, as the club has also decided to increase the stability of the squad compared with the past in order to facilitate the integration of the youth team exports with more experienced players.

Nevertheless, Lyon’s ascent has been in large part down to their ability to play the transfer market better than any other club in Europe, which was recognised by Simon Kuper and Stefan Szymanski in their thought-provoking book “Soccernomics”, where they dedicated an entire section to Lyon’s transfer market rules. These are essentially an extension of Aulas’ winning theme that was outlined above, owing more than a little to the “Moneyball” theories of Billy Beane, the legendary general manager of the Oakland Athletics baseball team.

The thinking goes like this: If you buy good players for less than they are worth, you will win more games. You will then have more money to buy better players for less than they are worth. The better players will win more matches and that will attract more fans (and thus more money).

"A lot on Puel's mind"

Lyon’s “magnificent seven” tips and tricks for the transfer market are as follows:

1. Exploit the inefficiencies of the transfer market. This means adopting an unsentimental approach whereby you sell any player if a club offers more than he is worth. As Aulas said, “Every international at Lyon is untransferable – until the offer surpasses by far the amount we had expected.”

2. Transfers should be decided by people who are at the club for the long-term. This means that Lyon’s transfers are decided by a group consisting of Aulas, the technical director, Bernard Lacombe, and whoever happens to be the current coach. As Emmanuel Hembert, head of the London sports practice of management consultants AT Kearney, explained, “A big secret of a successful club is stability. In Lyon, the stability is not with the coach, but with the sports director, Lacombe.” Lyon understand that the coach is only a “temp” better than most, as their seven consecutive titles were gained with four different coaches (Jacques Santini, Paul Le Guen, Gérard Houllier and Alain Perrin), while Lacombe has been at the club for over 20 years.

3. The best time to buy a player is when he is in his early twenties. Aulas explained, “We buy young players with potential who are considered the best in their country, between 20 and 22 years old. “ The theory is that the players are old enough to be nearly fully formed, but too young to be expensive stars. The other added benefit is that relative unknowns accept modest salaries.

"Bernard Lacombe - Lyon legend"

4. Try not to buy centre forwards. This is the most over-priced position in the transfer market in marked contrast to goalkeepers, who deliver most “bang for your buck”. In this way, the homegrown Benzema was given his opportunity and thrived on the responsibility, before making bundles for the club.

5. Replace your best players before you sell them. This avoids a panic purchase or a lengthy transitional period. This policy meant that Aulas could happily let Essien to go to Chelsea when they turned up with a wheelbarrow full of cash.

6. Buy Brazilians. Lyon have been very adept at securing footballers from Brazil, with former players including future internationals Edmilson, Juninho and Fred, while the current squad boasts Cris and Michel Bastos. The trick here was to send one of their past captains, Marcelo, to Brazil to act as an exclusive agent.

7. Help your foreign signings settle in. It is difficult to move to another country, but Lyon employ people to help their players relocate, find somewhere to live, learn French, open bank accounts and generally cope with homesickness. This sounds obvious, but many clubs did not provide such services a short while back.

Up until recently, this has proved to be extremely lucrative business for Lyon with net receipts of €21 million in the four years up to 2009 as purchases of €199 million were more than compensated by sales of €220 million. In that period, player trading generated an almost unbelievable €164 million profit. This was epitomised in the summer of 2009 when Benzema’s sale was the fourth highest in that window, though it was somewhat overshadowed by the megabucks splashed out on Ronaldo, Ibrahimovic and Kaka.

This trend continued this summer, when only Olympique Marseille came anywhere near to Lyon’s €24 million net spend in France, which included €22 million on the new glamour boy of French football, Yoann Gourcuff. All of a sudden, Aulas has loosened the purse strings and Lyon have become the big spenders.

"Lisandro - part of last summer's spending spree"

So why change the habits of a lifetime? This seemed to make no sense, especially when the policy had been working so well. Apparently, this is all about making the jump to the next level. The board explained the modified approach in the 2009 management report, “We decided to invest in experienced players in order to close the gap with the major European clubs”, as they saw an opportunity to close the disparity as other clubs were suffering more from the economic recession, given Lyon’s undoubted financial strength.

To an extent, this has not been such a bad move, if you consider the progress to last season’s Champions League semi-final, but it’s unlikely to be a permanent change in the long-term strategy, as the most recent management report re-affirmed the club’s commitment to its tried-and-trusted business model, “The trading target for 2010/11 will be to re-establish a significant excess of player registration sales over purchases.”

Whether this is as straightforward as it was a few years ago is open to debate, as the unfavourable economic conditions have definitely slowed down the transfer market with this summer’s spending in Europe’s top five leagues nearly 40% less than in the summer of 2009. OK, it is true that this may have been impacted by the World Cup starting at the same time that the transfer window opened, but there is little doubt that clubs have been hit by the financial downturn, so they now think twice about making expensive new acquisitions.

Having said that, Lyon’s focus on the transfer market remains laser sharp. This is confirmed by the club’s management report explicitly listing the market value of its players as €208 million (source – Transfermarkt), implying a potential capital gain of €74 million, after the book value is deducted. As this figure does not include an estimate for their younger players, they contend that the total value for the team is more like €220 million, which would suggest a capital gain of €86 million. It is extremely rare that clubs draw attention to this unrealised gain in their accounts, which only underlines the importance of player trading to Lyon’s strategy.

This is further highlighted when you look at the revenue from Lyon’s core business, which last year amounted to just €146 million. Not terrible by any means, but a long way behind Europe’s leading clubs, which is where they aspire to be. Lyon are the best placed French club in Deloittes Money League, based on 2008/09 results, which is one place ahead of their rivals Olympique Marseille.

However, the top Spanish and English clubs enjoy far higher revenue, while the German and Italian clubs also earn much more. Real Madrid and Barcelona generate almost three times as much revenue, while Manchester United earn more than twice as much and even a relatively unsuccessful team like Hamburg have a turnover higher than Lyon. There’s effectively a €50 million shortfall against the next tier of clubs (around €200 million turnover), which to date Lyon have traditionally made up by astute wheeler dealing in the transfer market.

This is abundantly clear when you examine Lyon’s revenue growth over the last five years – or I should say lack of growth. Their revenue has only grown 14% from €128 million in 2006 to last year’s €146 million and almost all of that growth came back in 2007. Although revenue did increase 5% this year, this was only after a steep decline in 2009. Over the same five-year period, expenses have risen by 52% from €133 million to €202 million. That’s a huge financial challenge right there and the only solution to date has been for the club to buy and sell its way out of trouble.

The importance of player trading can be seen very well in the above graph. If profit on player sales is considered as “revenue”, its contribution has been notable in the past few years, often double the money received from gate receipts. However, when that well dries up, as it did in 2010, the effect is evident and immediate.

However, broadcasting is still the largest revenue source with €78 million contributing over half of Lyon’s revenue. This is not the highest reliance on television money in the Money League, but it’s probably still a little too high for comfort. Revenue from the LFP (Ligue de Football Professionnel) and FFF (Féderation Française de Football) amounts to €49 million, while distributions from UEFA for the Champions League are worth €29 million.

Like every other club in Europe, Lyon’s broadcasting revenue is miles behind Real Madrid and Barcelona, whose ability to negotiate individual deals (for the time being at least) gives them astonishing TV revenue around €160 million, but it’s also at least €20 million behind other teams in their peer group. It’s difficult to see this situation changing any time soon (or ever), as it was touch and go whether the current French deal would even be as much as the previous one. In the end, the French TV rights were granted to Canal Plus and Orange under a four-year contract from 2008 to 2102 in a deal worth €668 million per season, which was slightly higher than the old agreement.

"Toulalan - younger than he looks"

The money is allocated as a mixture of fixed and variable components. The fixed element comprises 50% of the total media rights and is distributed equally among all Ligue 1 clubs, while the remaining 50% is distributed based on performance and media profile. This is fairly complex, so 28% is based on league position (23% for the current season and 5% for performance over the last five seasons); 19% is based on the number of games broadcast (14% for the current season and 5% for performance over the last five seasons); and 3% is intriguingly based on attacking play (“le challenge de l’offensive”).

Much of the €10 million increase in TV revenue was down to Lyon’s successful run in the Champions League with UEFA’s distribution growing from €24 million to €29 million. These payments are a combination of performance (how far the team progresses) and a variable share of the TV pool. The latter is partly dependent on the relative importance of the French TV market, but also importantly how many French clubs take part in the Champions League. For example, Lyon estimated that if only two French clubs had qualified for the group stages in 2009 (instead of three), their revenue would have been €4 million higher.

Although Aulas has argued that failure to qualify for the Champions League would not be a damaging blow to Lyon’s finances, as they have plenty of money saved for a rainy day, he has also admitted that the club’s annual budget is built on the assumption of a “podium finish” in Ligue 1 and reaching the quarter-finals in the Champions League. Over the last three years, Lyon has earned an average of €27 million a season from Europe’s premier tournament, which could potentially be even higher in the future, as UEFA’s new three-year contract for 2009 to 2012 is up 34%. Given these figures, I would argue that the Champions League is very important to Lyon – about 20% of total revenue, in fact.

"Hugo Lloris - brilliant orange"

In contrast to television, commercial revenue fell 13% (or €6 million) to €43 million in 2010, the second year in a row that it declined, following a €10 million decrease in 2009 from the high point of €59 million. Again, although this might be pretty good for a French club, it’s still not competitive on the international stage.

In fact, revenue from sponsorship and advertising was down sharply this year. This was partly due to the recession afflicting all industries, but in fairness Lyon were also impacted by a couple of exceptional factors specific to them: the repeated postponement of the French online gaming law meant that new sponsor BetClic was not authorised to place advertising on players’ shirts; and the club made a once-off €4 million payment to Umbro as compensation for the early termination of their contract to supply kit.

The decrease in commercial revenue in 2009 was similarly influenced by once-off movements, with the previous year being boosted by a €3.5 million signing fee from Sodexo for the catering contract and €1.8 million in prize money from Lyon’s victory at the Peace Cup in South Korea. In addition, the club’s restaurant business was outsourced and its brasserie discontinued, leading to a €1.3 reduction.

"Bastos keeps his eye on the ball"

However, the club do expect commercial revenue to “rise substantially thanks to new contracts”. Lyon has signed a ten-year agreement with Adidas as their exclusive kit manufacturer, starting from July 2010, with the supplier paying a basic fee plus royalties based on product sales. Merchandising revenue is likely to increase, both in France and especially abroad, on account of Adidas’ extensive distribution network. The contract could generate gross revenue between €80 million and €100 million depending on results on the pitch.

As Mangas Gaming has now been awarded a licence to operate in France, the BetClic brand can finally appear on players’ shirts in domestic football. This is a four-year deal worth €5-7 million per annum, which runs from 2009 to 2013 and replaces the long-standing agreement with Accor and Renault Trucks.

In September 2007, Lyon signed a contract with Sportfive, valid for ten years from the delivery of the new stadium, whereby Sportfive will have exclusive use of all marketing, hospitality and media rights belonging to the club. In return, Lyon receive a €28 million signing fee upfront, which is paid in four annual installments of €7 million between December 2007 and December 2010. By the way, this is the same company that has put into place a similar funding arrangement for Juventus’ new stadium.

Finally, the club has ambitious plans to grow its brand internationally through the establishment of soccer schools outside France in Northern Africa, the Far East, India, the Middle East and the USA. This will help cement the idea of Lyon as a club known for training and developing elite players.

Thanks to Lyon’s tremendous performance in the Champions League, match day revenue rose €2 million to €25 million, but this remains one of the lowest in the Money League. In fact, only three teams in the top twenty have lower revenue from this stream: Borussia Dortmund, Roma and Juventus. This is obviously constrained by the smallish capacity of their ground, the Stade de Gerland, which only holds 40,500, though the average attendance is even lower at 35,600, which means a capacity utilisation of 88%.

Despite this failure to fill the existing ground, the club has planned a new 60,000 stadium, which is due to be completed in December 2013, as this should provide a significant uplift to their revenue. In the shareholders’ meeting in December 2009, the board specifically drew attention to the impact of the Emirates Stadium on Arsenal’s match day income, which has more than doubled to around €110 million since the move.

This is because the Emirates is a more modern and commercially orientated stadium. In the same way, Lyon’s project aims not only to increase ticketing revenue significantly, partly through more corporate boxes, but also to develop ancillary revenue from a leisure centre, hotels, restaurants, offices, a shopping centre, including a dedicated OL store for merchandising, and potentially naming rights.

"Here's to future days"

The club’s initial estimates of the investment required were between €250 and €300 million, but this has reportedly risen to around €350 million. The presentation to shareholders claims that this will be 100% privately funded via “innovative financing” with very limited impact on the taxpayer, but there are reports that €180 million of public money will be used, presumably to improve transport links.

Although there has been some opposition to the new stadium, the project has been boosted by the awarding of the Euro 2016 tournament to France. The proposed stadium is one of the 12 on the short-list and should benefit from a new law that is to be introduced with the aim of enabling France to honour its commitments to UEFA, which will accelerate planning procedures.

On the cost side, the wage bill rose by a staggering 17% to €112 million, though this was explained as being primarily due to performance-related bonuses for advancing so far in the Champions League. This is the same issue that has caused Barcelona so many financial problems over the last couple of years. To be fair, French clubs are hampered by what Aulas wryly calls “Europe’s most developed tax system.”

Even so, it is clear that the wages have grown too far, evidenced by the wages to turnover ratio of 76%, which is higher than UEFA’s recommended maximum limit of 70%. This ratio has been on a steady upwards trend over the last few years from a respectable 59% in 2006.

In the management report, the board explicitly states that it “has set itself the target of significantly reducing the payroll over the next two periods, as other French clubs seem to be doing.” This does not seem to be an idle boast, as they have already offloaded many high-earning players this summer, including former captain Sidney Govou, Mathieu Bodmer, Jean-Alain Boumsong and Frederic Piquionne. These sales might not have brought in much money, but they will go a long way to reducing the wages to a more sustainable level, cutting around €12 million from the annual cost base.

The trend in player amortisation, namely the annual cost of writing down the cost of buying new players, also reflects the modified approach to the transfer market. In the three years between 2006 and 2008, it hardly changed at all, rising slightly from €24 million to €26 million. However, in the last two years it has grown to €43 million “as a consequence of the club’s substantial investments,” increasing by €9 million (a chunky 26%) this year alone. This is still much lower than those sides that have spent really big in the transfer market, such as Manchester City €83 million, Barcelona €71 million, Real Madrid €64 million and Chelsea €57 million. Furthermore, if Lyon’s board carries out the plans that it has announced, then it might well have maxed out at this level.

It should be clearly stated that in spite of this significant player investment, the club maintains that it still has a “sound financial structure with surplus cash” with the summary report for June 2010 stating that the club has positive net cash of €15 million.

Unfortunately, we don’t have any more details behind this, but we know from last year’s annual report that the club had net cash of €62 million in June 2009, so the recent player purchases must have had some effect, as the net cash has dropped by €47 million in the last 12 months. Looking at those 2009 figures, Lyon had very little financial debt at that stage with only €42 million of bank loans, which were more than covered by €104 million of cash.

We should note en passant that the club also owed €36 million to other football clubs a year ago, though this was completely offset by €62 million owed to them by other clubs, leaving a net football surplus of €27 million. So, last year’s analysis showed that Lyon had a net surplus of €89 million per UEFA’s definition, which is very impressive. This year’s figures will not have been quite as good as that, but they must still be very healthy indeed.

In addition, the club has shareholders’ equity of €131 million, which has given it sufficient robustness to pursue its ambitious growth policy. To put this into context, Lyon’s equity represents 44% of the total equity of French football clubs. Much of this is derived from the club’s successful flotation in 2007 on Euronext Paris, after a change in French law permitted sports clubs to float on the stock exchange, which raised €91 million.

Lyon’s board directors own the majority of these shares with Aulas himself having the largest stake (34%) through his holding company ICMI, followed by Pathé and OJEJ (24%), companies controlled by Jérôme Seydoux, and a further 7% held by other board members. However, the percentage of voting rights held is even higher, amounting to around 76%: ICMI 42%, Pathé and OJEJ 29%, other board members 5%.

"The only way is up"

Even with this stability, the club has plans to further strengthen its financial capacity, maybe to help raise funds for the new stadium. First, the board will subscribe to a €40 million capital increase for one of the group’s subsidiaries, OL SASP, through a partial incorporation of its shareholder loan and, on top of that, the club will issue €25 million in bonds or similar securities that could give deferred access to share capital.

The club’s presentation to shareholders concluded that theirs was “an exemplary business model.” Although that might sound a little bombastic, there’s no doubt that the model has proven itself over several years, though it’s fair to say that it has been severely tested by recent events. Having achieved the first two phases of Olympique Lyonnais’ grand plan, Aulas now talks of a “new phase of development” which will use the new stadium project to “pursue our objective of moving the club to a higher plane.” The ultimate objective, written down for all to see, is to “win a European Cup before 2016.”

Aulas once said that it is only a matter of time before his team wins the Champions League. If they managed to do that, with all the financial disadvantages they have compared to the traditional leading clubs, then they truly would be the Kings of Lyon. Is it likely? Who knows, but stranger things have happened.

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